ESMA publication on risks related to climate shocks and greenwashing controversies


On 19 December, the European Securities and Markets Authority (ESMA) published two “risk articles” regarding the impact of climate-related risks in the fund sector (1) and risks derived from greenwashing controversies (2).

The publications confirm the proactivity of ESMA in its response to the European Commission’s request for input on greenwashing risk and fulfill its mandate of ensuring market stability and investor protection.

Key elements of both publications are detailed below.

1.      Dynamic modelling of climate-related shocks in the fund sector

ESMA’s approach to modelling of climate-related shocks in the fund sector has been conducted within the mandate granted by the European Commission to perform regular climate change stress tests or scenarios and develop methods, parameters and scenarios for supervisory to use their own climate stress testing.

The article published by ESMA outlines the importance of identifying vulnerabilities of the investment fund sector under climate stress scenarios, including modelling the impact of asset price shocks.

In that respect, various climate scenarios may be used to generate shocks on asset prices. The dynamic model used by ESMA considers the impact of the reaction of both investors and managers, including the result of an outflow of investors. In that context, the dynamic analysis suggests that the investment fund sector may be less resilient than in a static analysis. In addition, portfolio rebalancing seems unlikely to make a large difference to major near-term vulnerabilities.

The dynamic model may amplify the short-term falls in asset value due to climate-related risks which may impact the sector’s financing in the green transition.

Further ESMA work on this topic may involve refining the calibration of the model and incorporating second-round price impacts.

2.      Financial impact of greenwashing controversies

ESMA uses the new term of “ESG controversies” to refer to “the allegations put forward by stakeholders and shared via local or international media, singling out individual firms or whole sectors with regard to their potential negative impact on environmental and social factors”.  ESG controversies cover, inter alia, “greenwashing controversies”, defined as “allegations put forward by stakeholders of perceived misalignment between sustainability-related communications and corporate actions”. It is important to note that greenwashing controversies are limited to greenwashing perceptions and not occurrences.

In the absence of a universally accepted definition of greenwashing, ESMA used the common understand developed by the ESAs in June 2023[1] to conduct its study.

First, ESMA shared findings on market trends and greenwashing controversies in the years 2020 and 2021. ESMA noted for instance that (i) the frequency of greenwashing controversies involving European firms increased between 2020 and 2021, (ii) the financial sector is the second most involved sector – after the gas and oil sector and before food and beverages, (iii) 28% of greenwashing incidents relate to five firms and that (iv) half of the greenwashing controversies are originated by NGOs.

The objective of the analysis is to understand the potential financial impact from the risks derived from greenwashing controversies on the targeted companies. Negative financial impacts on the stock return as well as the firm value are not clear and systematic in 2020 and 2021. There is indeed no clear correlation between the stock return of a company and its involvement in greenwashing controversies or on the private equity ratio and number of controversies targeting the company.

That said, in the absence of a common definition for greenwashing and the subjective dimension of ESG controversies, ESMA highlights the fact that the results should be interpreted cautiously. In addition, it may also mean that investors did not pay close attention to greenwashing-related controversies in the years 2020 and 2021.

Given the increase of greenwashing risks in the EU market and the noted impact on consumers’ trust and investors’ confidence, investors are likely paying more attention to greenwashing controversies than the past few years so that the analysis would definitely have to be conducted again in the current environment. 

ESMA thus confirms the absence of an effective market-based mechanism to help prevent potential greenwashing behaviour and the necessity to provide guidance by regulators and necessary efforts of supervision to maintain the trust of investors and the public in the financial sector to finance the transition to low-carbon economy.

This analysis on greenwashing controversies follows the progress report published by each of the European Supervisory Authorities (ESAs) in June 2023 and the recent update of ESMA on the publication of the guidelines on funds’ name, which aims to be another tool to tackle greenwashing risks. As the work on greenwashing risks is progressing at the level of the European Union, more developments on the topic are expected to come in 2024.

Please do not hesitate to contact our experts for more information on this topic.

[1] ’a practice where sustainability related statements, declarations, actions, or communications do not clearly and fairly reflect the underlying sustainability profile of an entity, a financial product, or financial services. This practice may be misleading to consumers, investors, or other market participants‘ ESMA 2023